^*Shanaka J. Peiris is a senior economist with the IMF's Monetary and Capital Markets Department. Magnus Saxegaard is an economist with the IMF's Asia and Pacific Department. The authors thank Andrew Berg, Doug Laxton, Jean A. P. Clément, Michel Juillard, Catherine Pattillo, Steven O'Connell, Manrique Saenz, Tsidi Tsikata, Reza Vaez-Zadeh, and participants in seminars in the IMF's African Department and Small Modeling Group.

Abstract

This paper evaluates monetary policy trade-offs in low-income countries using a dynamic stochastic general equilibrium model estimated on data for Mozambique, taking into account the sources of major exogenous shocks and the level of financial development. The simulations suggest that an exchange rate peg is significantly less successful than inflation-targeting at stabilizing the real economy due to higher interest rate volatility, as in the literature for industrial countries and emerging markets.